Why Is It Important to Manage Cash Flow?
People go into business for a variety of reasons, but one thing that’s consistent across all business sectors is the desire to have a profitable and successful business. While people may define success in different ways, in an economic sense positive cash flow is inherent to that success.
Why Cash Management Is Key to Business Success
What is cash flow, and why is it important to manage cash flow?
In simple terms, cash flow refers to the movement of money coming in and going out of your business. Cash flow is different to profit and is not counted until operating costs are paid and payment for goods or services is received.
If you enter business without understanding how to manage cash flow effectively or if your business scales too quickly, you may find yourself in a state of negative cash flow, where you have more money going out than coming in.
Negative cash flow that isn’t soon reversed can lead to concerns around solvency and the need for professional intervention such as business recovery. If that occurs, it doesn’t only impact your business, but also potentially the assets and liberty of the directors and your ability to meet financial commitments, including paying your employees.
The follow-on effects of negative cash flow can be felt beyond the business, into families and even communities. Positive cash flow, however, is a great measure of the success of your business and its ability to keep functioning and growing.
According to business.org, ‘cash flow can be an even more important measure of your business health and eventual success than your revenue or profit.’ The ability to keep bringing in more cash than is going out enables you to meet all financial commitments and to continue providing your product or service. As such, cash management is key to business success.
Benefits of Good Cash Flow Management
Good cash flow management enables business success. This can include measures such as:
- Covering all operating costs and turning a profit.
- Maintaining current clients and fulfilling orders.
- Avoiding the need for business recovery turn around, business recovery, or even administration.
- Maintaining your professional reputation as a business and professional.
- The opportunity for future growth.
- Sound financial basis to attract potential investors.
How to Manage Cash Flow Effectively
To reap the benefits of good cash flow management, it’s crucial for a business to know how to manage cash flow effectively.
One of the key cash flow management techniques available to businesses is keeping a cash flow statement. This enables businesses to see what is outgoing and incoming in each measurement period.
Being aware of the rhythm of your sector and knowing the slow and fast periods of your industry is important in managing the in and out flows wisely. Knowing the timeframe of money coming in and going out is also crucial to managing cash flow effectively. Similarly, shortening the cash flow conversion period (for example requesting payment via email rather than mail) enables your business to have that money flowing back into the business sooner.
Another of the main cash flow management techniques is financial forecasting. While the data from cash flow statements is vital to understanding the business’s financial position, as highlighted in a recent article it’s important to ensure you are forward-facing, rather than rear-facing in your cash flow management strategies.
Creating a financial forecast enables you to consider not only your own business’s current cash flow, but also industry trends, considering variables such as government policy and the impact of global events such as the pandemic and impact on financial markets. In this way, your business can predict where cash flow will be most needed at different times and plan accordingly.
Another key strategy in cash flow management is running regular cash flow analyses. This includes comparing your actual cash flow to your projected cash flow or forecast, which enables you to pick up any expenditure that may have been overlooked or miscalculated, and adjust accordingly. Using historical data coupled with future projections can help a business develop a solid business plan which may attract potential investors. An injection of funds via debt or equity financing is often utilised as one of the important cash flow management strategies at certain points in the growth of a business.
Finally, gaining professional tailored advice from experts in solvency and business success is an excellent step towards managing your cash flow effectively.
At Irwin & Company, we’re experts at helping businesses plan for success. If you’d like assistance with cash flow management strategies, contact Irwin & Company today for professional and tailored advice.